Q&A: Taking back a Roth contribution
Posted on 31 March 2010
By Mark Miller
Permanent URL of this article: http://retirementrevised.com/money/qa-taking-back-a-roth-contribution
Q: My wife and I are both over 60 years old. We each made a $6,000 contribution to Roth IRA on April 1, 2009. We now realized that we are a little over the $176,000 maximum adjusted gross income limit (AGI) for tax year 2009 to qualify us to contribute to a Roth for 2009. Both our Roth IRA contributions are in CD accounts. We would like to abort/negate our 2009 contributions to avoid penalties on April 2010 when they mature.
Are there penalties if we withdraw the funds from the Roth accounts? Can we can include the earned interest as ordinary interest income in our 2009 tax return?–F.B., via the Internet
A: Assuming the contributions were made as 2009 contributions, you have a couple of options, says Jeffrey Levine, IRA technical consultant at Ed Slott and Company, publisher of the authoritative IRA Advisor newsletter.
“Option one would be to recharacterize the Roth IRA contributions to IRA contributions,” Levine says. “You have up until October 15th of 2010 to recharacterize a 2009 contribution. If neither of them participated in a company plan last year, they could take a full deduction for each of their contributions.
“If either of them was an active participant in a plan last year though, then their income was too high to claim any deduction. They can still recharacterize those contributions to a traditional IRA, but they would be non-deductible contributions and should be accounted for properly on form 8606 of their return. They could then convert these funds back to a Roth IRA after waiting more than 30 days. If this is the only IRA money each of them has, then the conversion would be virtually tax free (except for the interest earned on the $6,000). If they have other IRAs though, the conversion would be subject to the pro-rata rule and this option may not make as much sense.”
“Option two would be to treat the contributions as excess contributions. Similar to recharacterizing, the deadline to do so for a 2009 contribution is October 15th, 2010. The important point here is to somehow make sure the custodian (the bank in this case) correctly classifies the distribution as a return of an excess contribution. If they choose this option, they not only should, but need to claim the interest earned as income on their 2009 return. They won’t actually receive the 1099-r’s for the distributions of excess contributions until 2011 (when 2010 1099-r’s come out) though. The formula for the net income calculation can be found in IRS Publication 590.
Levine notes that all the advice above is based on what the federal tax code allows. “I know of many cases where the bank makes it difficult with the customer and will not recharacterize or code a contribution as an excess contribution as long as it’s in the CD. Instead, some banks will require a customer “break” their CD to do so, subjecting them to interest penalties – not tax penalties.
“So, find out what your bank will allow. They may be able to make these elections at anytime, or they may have to wait until the CD matures to do so without the bank charging them a penalty for breaking their CD. No matter what though, they need to take action prior to October 15, 2010 or they will each incur a 6% excise penalty for an excess contribution for each year the excess remains in the Roth IRA.
